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Valuing companies by cash flow discounting: Ten methods and nine theories


  • Fernández , Pablo

    () (IESE Business School)


This paper is a summarized compendium of all the methods and theories on company valuation using cash flow discounting. The paper shows the ten most commonly used methods for valuing companies by cash flow discounting: 1) free cash flow discounted at the WACC; 2) equity cash flows discounted at the required return to equity; 3) capital cash flows discounted at the WACC before tax; 4) APV (Adjusted Present Value); 5) the business's risk-adjusted free cash flows discounted at the required return to assets; 6) the business's risk-adjusted equity cash flows discounted at the required return to assets; 7) economic profit discounted at the required return to equity; 8) EVA discounted at the WACC; 9) the risk-free rate-adjusted free cash flows discounted at the risk-free rate, and 10) the risk-free rate-adjusted equity cash flows discounted at the required return to assets. All ten methods always give the same value. This result is logical, since all the methods analyze the same reality under the same hypotheses; they only differ in the cash flows taken as starting point for the valuation. The disagreements in the various theories on the valuation of the firm arise from the calculation of the value of the tax shields (VTS). The paper shows and analyses 9 different theories on the calculation of the VTS: No-cost-of-leverage, Modigliani and Miller (1963), Myers (1974), Miller (1977), Miles and Ezzell (1980), Harris and Pringle (1985), Damodaran (1994), With-cost-of-leverage and Practitioners method. The paper contains the most important valuation equations according to these theories, and also shows the changes that take place in the valuation equations when the debt's market value does not match its book value.

Suggested Citation

  • Fernández , Pablo, 2002. "Valuing companies by cash flow discounting: Ten methods and nine theories," IESE Research Papers D/451, IESE Business School.
  • Handle: RePEc:ebg:iesewp:d-0451

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    References listed on IDEAS

    1. Isik Inselbag & Howard Kaufold, 1997. "Two Dcf Approaches For Valuing Companies Under Alternative Financing Strategies (And How To Choose Between Them)," Journal of Applied Corporate Finance, Morgan Stanley, vol. 10(1), pages 114-122.
    2. Kaplan, Steven N & Ruback, Richard S, 1995. " The Valuation of Cash Flow Forecasts: An Empirical Analysis," Journal of Finance, American Finance Association, vol. 50(4), pages 1059-1093, September.
    3. Fernandez, Pablo, 2004. "The value of tax shields is NOT equal to the present value of tax shields," Journal of Financial Economics, Elsevier, vol. 73(1), pages 145-165, July.
    4. Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, vol. 32(2), pages 261-275, May.
    5. Miles, James A. & Ezzell, John R., 1980. "The Weighted Average Cost of Capital, Perfect Capital Markets, and Project Life: A Clarification," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 15(03), pages 719-730, September.
    6. Lewellen, Wilbur G. & Emery, Douglas R., 1986. "Corporate Debt Management and the Value of the Firm," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 21(04), pages 415-426, December.
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    Cited by:

    1. Magni, Carlo Alberto, 2009. "Splitting up value: A critical review of residual income theories," European Journal of Operational Research, Elsevier, vol. 198(1), pages 1-22, October.
    2. Nangia, Vinay Kumar & Agrawal, Rajat & Reddy, K. Srinivasa, 2011. "Business Valuation: Modelling Forecasting Hurdle Rate," MPRA Paper 60420, University Library of Munich, Germany, revised 2011.
    3. Jennergren, L. Peter, 2004. "Continuing Value in Firm Valuation by the Discounted Cash Flow Model," SSE/EFI Working Paper Series in Business Administration 2004:15, Stockholm School of Economics.
    4. Barajas, Angel, 2004. "Modelo de valoración de clubes de fútbol basado en los factores clave de su negocio
      [Valuation model for football clubs based on the key factors of their business]
      ," MPRA Paper 13158, University Library of Munich, Germany.
    5. Girish K. Nair & Lewlyn Lester Raj Rodrigues, 2013. "Dynamics of Financial System: A System Dynamics Approach," International Journal of Economics and Financial Issues, Econjournals, vol. 3(1), pages 14-26.
    6. Patrick Boisselier & Dominique Dufour, 2007. "Comptabilite Et Valorisation A L'Introduction Sur Alternext (2005-2006)," Post-Print halshs-00544917, HAL.
    7. Reddy, Kotapati Srinivasa, 2015. "Determinants of Cross-border Mergers and Acquisitions: A Comprehensive Review and Future Direction," MPRA Paper 63969, University Library of Munich, Germany, revised 2015.
    8. Xie, En & Reddy, K.S. & Liang, Jie, 2017. "Country-specific determinants of cross-border mergers and acquisitions: A comprehensive review and future research directions," Journal of World Business, Elsevier, vol. 52(2), pages 127-183.
    9. Fernandez, Pablo, 2006. "The correct value of tax shields: An analysis of 23 theories," IESE Research Papers D/628, IESE Business School.

    More about this item


    Financial management; Company valuation;

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General

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